Fourth Federal District Court Looks Likely to Uphold Fiduciary Rule

By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as scribbles occasional travel pieces for The National.

Trump is “maniacally focused” on fulfilling his campaign pledges, chief strategist Steve Bannon told The Guardian in a piece published yesterday. This has resulted in a flurry of executive orders and a plethora of tweets, the latter often emanating in the wee hours of the Washington morn.

Yet as Yves has written, the legal force of some of these measures– no matter how couched in legalese they may appear– has no greater weight than would mere issuance of a press release. During the campaign, Trump promised to roll back the Dodd-Frank financial regulatory edifice, and on February 3, he issued an executive order purporting to be the first step in doing just that. But the president cannot just undo existing law, by by fiat, whether covered by the fig leaf of an executive order or not.

On the same day, Trump issued a Presidential Memorandum on Fiduciary Duty Rule, in which he directed the Department of Labor (DoL) to conduct an examination of the a new fiduciary rule, due to come into effect on April 10. This rule would impose a basic fiduciary duty standard  on investment advisors, requiring them to act in a client’s best interest.  The fiduciary rule replaces the previous suitability standard, which consumer advocates have criticised for allowing investment advisors to provide conflicted advice, motivated by fees. This suitability standard imposes costs estimated at $17 billion annually on investors and depresses investment returns on retirement savings by a percentage point. Brokerages and insurance companies rely heavily on commission-based compensation.

As reported by The Wall Street Journal in an article entitled Brokers Spared From Fiduciary Rule:

“Repealing the rule frees up brokers and insurance agents to go back to recommending what’s most profitable for them rather than what’s best for their customers,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “And it frees up firms to keep the toxic financial incentives in place that encourage and reward advice that is not in customers’ best interests.”

Yet as spelled out in a National Law Review article, Status of the Fiduciary Rule,

Contrary to popular perception, the Memorandum did not direct the Department of Labor (DOL) to delay the applicability date of the Fiduciary Rules. However, shortly after the Memorandum was signed by the president, the acting secretary of the DOL released a statement saying the DOL would be reviewing its legal options for delaying the applicability date.

While the DoL might in the long run not rescind the rule after all, in the short term, it’s widely expected that the agency will delay the rule’s April 10 compliance deadline. The situation has been further complicated by the withdrawal of Andrew Puzder’s nomination as Labor Secretary. Trump moved quickly to nominate Alexander Acosta, a former member of the National Labor Relations Board, who also served as a US Attorney for the southern district of Florida during the administration of President George W. Bush.  Yet that nomination has yet to be confirmed by the Senate, and in the interim, business at the DoL will likely stall.

Congress might step in at any time and pass legislation to rescind the rule. Trump would almost certainly sign such a bill. Whether this would happen depends on what interim steps the DoL takes and the outcome of pending legal challenges, as well as whether opponents muster sufficient lobbying muscle to force such an outcome.  This latter point may be less certain than it first appears. As I elaborate further below, some firms have already taken steps to comply with the framework that it was believed would apply from April 10 onward and they might not necessarily wish to unwind such arrangements now.

Legal Challenges

Meanwhile, at least four legal challenges have been filed concerning the fiduciary rule. If challenges were to succeed, and a court had overturned the rule– as federal courts have done with some  Dodd-Frank provisions, for example– any DoL review of the rule could be rendered moot. The legal situation is a bit unusual in that since the Trump administration’s position on the rule is opposite to that of its predecessor– which promulgated this rule. So if the government were to lose one of these challenges, I’m guessing it would opt not to appeal any decision to vacate the rule.  (My explanation might appear confusing unless one recognizes that these cases were pending before Trump became president, so that the government’s position in these actions thus far has been to argue in favor of the new fiduciary rule.)

So far, however, no federal district court judge has ridden to the Trump administration’s rescue, and in fact,  the three federal district courts that have ruled– sitting in Washington DC, the northern district of Texas, and Kansas, respectively– have each granted the government’s motion for summary judgment, thus upholding the rule. Judges Randolph Moss (DC) and Daniel Crabtree (Kansas)– are Obama appointees, while chief judge Barbara Lynn (Texas) is a Clinton appointee. Various appeals remain pending and I decline to speculate on these at this time.

On Wednesday, February 22, federal district court Judge Susan Richard Nelson (of the district of Minnesota), rejected the Department of Justice’s (DoJ), request for a stay of the rule, pending the outcome of the DoL review. Judge Nelson is due to rule on a summary judgment motion on March 3. If I were to hazard a guess, it would be that Judge Nelson– also an Obama appointee– is likely to rule consistently with the other three decisions, and uphold the rule.

Chief Judge Barbara Lynn’s ruling in Chamber of Commerce v. DOL is the most comprehensive treatment of the issue  handed down to date. This 81 page opinion suggests that the DOL will find it difficult to find grounds for rescinding the new fiduciary rule outright– although as I mentioned above, the DoL will likely seek to delay implementation beyond the April 10 implementation date. Losing counsel in this case, Eugene Scalia– son of the late Supreme Court Justice Antonin Scalia– has  a “a strong track record for winning legal challenges to kill off unwanted Wall Street regulations“, according to Reuters, and these — include some Dodd-Frank provisions.

What Happens Next?

With the legal status of the new rule remains uncertain, where does that leave investment advisers? Procedures for complying with such a complicated framework are not developed overnight, and many investment advisers had already taken steps to conform theirs to the new framework that was slated to come into effect in April.  The WSJ article quoted above suggested that some brokerages would proceed with at least some their plans to institute new procedures or retain those already in place. In particular:

Merrill Lynch, which has more than $2 trillion in client assets, has said it would stick with its plan, announced in October, to end commission-based retirement accounts even if the rule gets killed. The Bank of America Corp.-owned brokerage will instead charge a fee based on a percentage of assets.

Morgan Stanley recently told its brokers it would move ahead in any political scenario with changes to product pricing, such as lowering the price of commissions tied to stocks and exchange-traded funds.

How long these and other firms would retain such resolve, however, is an open question, in the event that the DoL finds sound legal grounds to rescind or alter the fiduciary rule. I should point out as well that despite the sound and fury occasioned by Trump’s February 3 memorandum on the new rule, actual financial sector practices depend not only on the letter of the law, but also are shaped by the enforcement climate. That has been notoriously lax since the financial crisis– despite rhetoric to the contrary. Where the Trump administration will come down on this crucial issue remains unresolved.

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7 comments

  1. Jim Haygood

    Barry Ritholtz, who runs a fee-based advisory service himself (and is thus an interested party), asserts that the fiduciary train has already left the station and it’s too late to stop it:

    Change is now inevitable. Industry expectations, based on an A.T. Kearney study, are that by 2020, “the DOL’s new fiduciary rule will result in a $2 trillion asset shift” that will save investors roughly $20 billion by not having to pay commissions.

    Look at the biggest wirehouses as an example. They had begun a shift toward fee-based accounts several years ago. Three years ago, 27 percent of Morgan Stanley’s client assets were fee-based; today more than 40 percent of client assets are in fee-based accounts. The shift is similar for Bank America Merrill Lynch’s more than 14,000 advisers – they report an increase from brokerage to fee-based for their $2.1 trillion in client assets.

    http://ritholtz.com/2017/02/fiduciary-genie/

    Commission-based advice on a “suitability” standard is an ancient, obsolete business model derived from the bad old days of fixed commissions on Wall Street, which typically ran north of one percent for individual investors. Fixed commissions ended in 1975. But Wall Street has soldiered on with its inherently conflicted model, which rewards account churning and high-fee in-house products.

    Investors have figured out that Wall Street’s commission-based model sucks balls, and as Barry says, “they have voted with their feet, and with their dollars.

    Here is a concise “Wall Street sleaze” roadmap, courtesy of Tim Maurer:

    Those beholden to the Investment Advisers Act of 1940 and regulated by the SEC are fiduciaries already, and they have been for a long time.

    [But] those who sell securities—typically known as stock brokers and regulated by FINRA—are held to a lesser “suitability” standard. Those who sell insurance products may be beholden to an even lesser standard—caveat emptor, or “buyer beware.”

    http://tinyurl.com/j2q6auq

    Unbelievable, ain’t it? In the world’s largest and most sophisticated securities market, Wall Street’s contempt for its suckers customers is flaunted right in our faces. And it’s “all legal.” Smash FINRA.

    1. lyman alpha blob

      Perhaps we need to have warning labels on brokerage account statements such as appear on cigarette packages –

      WARNING: Investing with our company may prove hazardous to your financial health as we are legally allowed to act in our own best interest and rip your face off should we so desire.

  2. anonymous

    Having seen a sketchy neighbor finally get booted out of brokering after a long-overdue FINRA investigative process, I shudder to think about how many small investors have been bilked, defrauded, hoodwinked and otherwise put into inappropriate investments. I encourage all readers to research your brokers or other advisors to find out what secrets and skeletons may be lurking in their closets.

  3. MLS

    Couple important points to note in all of this:

    1) the fiduciary standard would only apply to retirement accounts. If you have a regular taxable account with a commission-based broker, they can continue to rake you over the coals if you’re not paying attention.
    2) many, MANY advisors (such as trust companies) already adhere to the fiduciary standard for all clients and all account types. Sure you probably won’t get that hot IPO or super-charged returns, but those kind of firms have a totally different set of regulators and are held to a far higher standard than traditional brokerage or RIAs. In other words, not all advisors are created equal, so do your homework on anyone you’re considering hiring, and most of all, ask questions.

  4. sunny129

    Every one should learn about money, taxes, debt/credit and investments. Should start with virtues of SAVING, instead of CONSUMPTION, first!

    If you don’t don’t control your financial destiny, some one else will!

    1. Melody

      Every one should learn about money, taxes, debt/credit and investments.

      Yes–and we should also learn all we can about healthcare, so we can appropriately have “skin in the game” in choosing our providers and insurance plans. Additionally, we should brush & floss three times a day; have annual check-ups and eye exams; take our car in for oil changes every 3,000 miles. So, too, should we be soccer moms and dads, who support our children’s extracurricular activities; watch Hell’s Kitchen so we can prepare our own meals; and monitor our family’s food choices and consumption; buy organic and shop local. Let us not forget we must work 40 hours a week, commute 5-10 hours a week; create an interesting social life for ourselves; and have that 20-minute/day exercise regimen. Don’t forget to check the smoke and carbon monoxide monitors with regularity; get 8-10 hours of sleep for optimum mental/physical well-being. Consider, too, to take time to learn to grow your own garden; You-tube all fix-it problems so we can be our own repair-persons. Remember to flip your mattress twice a year, treat yourself to a bi-weekly mani-pedi, and schedule appropriate play-dates for your children. Keep track of all your deductions to please your taxman come April 15th, and please stay abreast of news–both domestic and foreign–so you will be an informed citizen. Remember to learn all you can about politics so you can be an informed voter. And just a reminder: check your FICO scores regularly, reconcile your checkbook monthly, and sign-in to your credit card accounts with regularity lest some unauthorized charges magically appear. Log-in with some frequency to be certain your automobile, your appliances or your medications have not been recalled or tagged with defects or adverse events. Participate in civic and religious activities; make sure your validate your charitable contributions as being worthy; and plan some “me-time” to recharge your batteries. Are your sure your latest phone plan, insurance policy, cable/satellite tv plan are REALLY what your signed up for: did you read all the 3-point type in their latest notification to you? Don’t forget family vacation time and continuing education (you DO want to stay abreast of your professional/career advancements, don’t you.)

      Sunny129–how many hours are in your day?

  5. A Republic If You Can Keep it

    The Fiduciary Rule is far more important than realized anywhere but in financial circles. It applies only to private pension funds, in particular 401(k)s, and, remarkably, to IRAs. It does not affect securities laws nor the SEC. (Except to shame the SEC, which has failed to adopt a similar rule for advisors to brokerage accounts.). The Rule is a creature of of federal pension law (ERISA) affecting private pensions and, quite remarkably, IRAs. It only pertains to persons and entities who offer investment advice. And then only to advice to private pension funds and IRAs. (What a writer above referred to as retirement accounts, which is a concept without any legal meaning.) It is the first time that the U.S. Department of Labor (DOL), which is the sole regulator of private pension funds and IRAs, has done anything regarding investment advisors since 1975 other than give to away the store to Wall Street and Finance, a year after federal pension law went into effect. (ERISA is a creature of the 1974 Watergate Congress.)
    The Fiduciary Rule is a long time coming. One reason it is so important is that federal pension law preempts state laws when it comes to private pension fund regulation. The other reason is that private pension funds are the largest pot of Other People’s Money (OPM) that exists. Trillions of dollars. Think of them as saved work by 50 million
    Americans which will be paid by the employer after they are 65. A fact that Finance and Wall Street have done their best to hide and keep the DOL from effectively regulating.
    The Fiduciary Rule is a regulation. The DOL proposed it in 2010, and adopted it in the summer of 2016. It interprets a 1974 basic federal pension law statute, ERISA 3(21)(A); 29 USC 1002(21(A). The text of the 3(21)(A) statute is strong enough but the DOL issued a regulation in 1975 which essentially gave an unknowing pass to advisors to 401(k) plans when section 401(k) was added to the Internal Revenue Code in 1978, three years later. The Internal Revenue Code also governs private pension plans. By the timorous DOL failing in the ensuing 39 years to update the regulation to apply to 401(k) plans, Wall Street and Finance have been able to rip off trillions of retirement funds. An example, Wall Street Firms have been able to advise 401(k) holders to roll out their 401(k) plan assets to the Firms’ IRAs, even though the IRAs are inferior to the 401(k) plan’s returns, have higher fees, are otherwise inappropropriate, and more risky. This was made possible because DOL’s 1975 regulation and subsequent supine DOL interpretations held that Wall Street Firms owed no “fiduciary duty” to the participants in the 401(k) Plans under the 1975 regulation. If the Department had interpretated 3(21)(A), clearly, simply, and obviously, the fiduciary duty would have applied to advisors to 401(k) plans and 401(k) account holders. Finally this started to change in 2010 after the global financial collapse (GFC), when the fiduciary rule was first promulgated.
    As I write this Tom Perez, Seecretary of Labor is shouting appropriately on the TV, having been named Democratic National Committee Chair, as if shouting louder makes up for a lack of history. Make no mistake, Perez will not counter Finance. The Fiduciary Rule is no exception. Perez inherited the Fiduciary Rule in midstream. He could not stop it without been seen as craven. His subalterns were committed to it. He is not that stupid. I am sure if he was DOL Secretary in 2010, it would not have been proposed.

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